How the Credit Crisis Stole Christmas

The holiday season of 2008 may go down in history as one of the biggest nail-bitters in the last few decades. Motley Fool analysts have assessed the state of retail going into this critical season -- the stocks, sales strategies, consumer trends -- and identified the winners and losers at the mall and in investors' portfolios.Click here for the complete report.

"How to survive the holiday season without debt."

I was absolutely stunned a few weeks ago as I watched the special segment headline flash across my television. While I've never owed a penny of debt in my life, I realize that many individuals rely on some type of financing for major purchases; some even for day-to-day life when times get tough. However, over the last decade, debt levels in this nation have exploded. And the pure fact that a segment on how to "rough it out" during the holiday season with only the cash you have on hand earned a prime time spot on CNBC left me dumbfounded. In fact, it made me downright embarrassed to be an American.

America runs on debtPerhaps I shouldn't have been so startled. Nearly two-thirds of holiday purchases each year are financed with credit cards, according to one estimate. Of course, not everyone racks up a bundle of debt. I myself am one to swipe a month's worth of expenses on my card and pay it off in full each month to take advantage of cash back rewards. Unfortunately, that's not always the case.

The global economy isn't in a credit crunch for no reason. Lenders are finally figuring out that borrowers are riskier than they previously perceived and are putting an end to dishing out credit to anyone with a desire to own something they can't afford. According to a recent Standard & Poor's survey, a quarter of consumers polled said they are at or near the limits on their primary credit card, and 20% said they are approaching the limit on their secondary card.

It's no wonder that many lenders are taking away the "spending power" they once granted. Roughly a quarter of respondents said they have had their spending limits cut. Kohl's recently stated that it has focused on reducing card approval rates, particularly in the regions hardest hit by falling real estate prices, like Florida and California.

This has magnified the consumer spending slowdown over the past year and has contributed to the gloomy holiday season outlook. It also reveals that previous years of heady spending habits were distorted by usage of debt.

I’m getting nothin' for ChristmasGranted, as a retail analyst, it's my worst nightmare to watch consumers pull back their spending, particularly during a quarter in which some retailers generate as much as half of their annual revenue. But frankly, I think it's sad that the sector will be hit so hard by the mere fact that consumers will have to finance their holidays with the cash in their pocket. Yet, the problem is real, and the effects will be more than evident in the next round of earnings. As an investor, it's imperative to understand how tight lending practices will significantly impact near-term spending and why some retailers will be hit harder than others.

While issuing in-house credit cards to consumers helps develop loyalty between retailer and customers, the effects of running a financing business on the side can be destructive to a retailer's bottom line when shoppers become strapped for cash. For example, Target (NYSE: TGT) , which generated roughly 13% of its 2007 operating profit from its financing division, saw an 83% decline in the segment's profitability during the third quarter as a result of higher bad debt expenses from write-offs. Further, retailers like Home Depot (NYSE: HD) and Sears (Nasdaq: SHLD) could lose as much as 8% of their holiday sales due to lenders and stores tightening their financing practices.

After years of leveraging up their lifestyles, consumers are finding themselves having to choose between what payments to actually make, as in many cases, the resources to repay all obligations simply do not exist. Typically, a mortgage payment will be made first, followed by traditional banking credit cards such as MasterCard (NYSE: MA) and Chase Card Services (a division of JPMorgan Chase (NYSE: JPM) ). Only then are retail cards usually paid off. Thus, investors studying a retailer's financials should look at whether companies are off-loading their credit card divisions to banks.

The combination of consumer pessimism about the general economy and the lack of credit has shoppers significantly reining back their holiday spending plans. According to American Research Group, the average planned spending on holiday gifts this year is $431. That’s down 50% from last year’s figure of $859.

And according to an NPD holiday spending survey, purchase intent for every category is equal to or lower than the claimed purchases last year. The most notable drop was the MP3 category, in which only 5% of shoppers planned to buy, compared to 10% last year. That's certainly not good news for Apple (Nasdaq: AAPL) or Microsoft (Nasdaq: MSFT) .

The power of plasticIn my opinion, the mid- to upper-tier retailers will feel the brunt of the holiday slowdown. In the past, consumers reached for a level of lifestyle made possible by plastic. It allowed middle-class consumers to peek over the barrier that separates the average from the rich. Without tapping a credit line, however, these consumers can't afford to make these purchases, even in good times.

Several of us Fools have been suggesting for a while that the debt-fueled spending habits must stop. It doesn't present a pretty landscape for specialty retailers like Coach or, more generally, for the 2008 holiday season. But the past several years of growth were unsustainable, and the credit crunch will both snap consumers back to reality and leave only the strongest of retailers standing.

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Just to comment on paying your MasterCard account. People do not pay their MasterCard account, MasterCard is simply a processor of transactions for banks or retail establishments. You pay the BANK who issued the card, you do not make payment to MasterCard. MasterCard does not issue credit, it only processes and that's how their money is made, every time you swipe a card that has the MasterCard logo on it, the credit issuer pays a fee for that transaction. All credit and payment issues are handled by the issuer (i. e. your BANK) and MasterCard retains no authority over payment agreements nor interest rates.